We may be shooting ourselves in the foot and hampering bitcoin adoption if we don’t change course quickly
The recent uproar around changes to the UCC seems are the result of a fundamental lack of understanding of commercial law, and we may be shooting ourselves in the foot and hampering bitcoin adoption if we don’t change course quickly.
Texas Blockchain Council, Bitcoin Today Coalition and Bitcoin Policy Institute are now coordinating to try to correct misperceptions being advanced by some in the bitcoin space around the impacts of recently proposed UCC amendments being voted on at the state level.
The crux of the UCC issue is very well laid out by Carla Reyes in her recently released paper: Emerging Technology’s Unfamiliarity with Commercial Law – “Far from advantaging CBDCs, the 2022 UCC Amendments promote stability and predictability in commercial transactions involving cryptocurrency.”
If you read nothing else in the paper, please focus on this paragraph. The bottom line is that these UCC amendments actually enshrine bitcoin’s core tenets in state laws around the country, while doing nothing to advance CBDC adoption.
If you are going to reach out to your state legislatures, please read Carla Reyes’s paper first and gain an understanding of the issue.
You can view Carla Reyes’s paper online in your browser by following this link and I will also include a copy of her paper below.
Over the course of a three-year, collaborative process that was open to the public, the Uniform Law Commission (ULC) and the American Law Institute (ALI) undertook a project to revise the Uniform Commercial Code (UCC) to account for the impact of emerging technologies on commercial transactions. The amendments, approved jointly by the ULC and ALI in July 2022, touch on aspects of the entire UCC, but one change has inspired ire and attracted national media attention: a proposed revision to the definition of “money.” The 2022 UCC Amendments alter the definition of “money” to account for the introduction of central bank digital currencies, such as the Bahamian Sand Dollar, and create a separate asset classification category for cryptocurrencies such as bitcoin — controllable electronic record. Opponents of this change state concern that the UCC seeks to “ban” cryptocurrency or otherwise advantage central bank digital currencies and disadvantage cryptocurrencies. This essay examines this dispute over the 2022 UCC Amendments, and argues that it stems from a misunderstanding of core commercial law concepts. Ultimately, it seems, diminishing familiarity with commercial law — a side effect of expanding reliance on emerging financial technology products — stands as a key obstacle to the enactment of a legal changes designed to give the objectors the very legal effects they desire.
Cryptocurrency stories of woe have dominated the news cycle since May 2022. Some of this news coverage reveals the general public’s lack of familiarity with commercial law concepts. For example, when a ruling in the Celsius bankruptcy determined that certain customer deposits belonged to Celsius, and, relegated customers to unsecured creditor status, the world generally seemed shocked. Well, everyone seemed shocked except commercial lawyers. Those lawyers familiar with the Uniform Commercial Code (UCC) and its interaction with the Bankruptcy Code might have predicted such an outcome, and, indeed, had they been consulted, might have helped prevent it. Unfortunately, as the regular use of checks and other negotiable instruments dwindles in favor of emerging financial technology products, commercial law familiarity also diminishes.
In a somewhat twisted turn of fate, emerging technology’s unfamiliarity with commercial law now threatens the adoption of key commercial law changes designed to improve the use of emerging payment mechanisms in commerce. This essay examines the proposed 2022 UCC Amendments6 and recent claims that the Amendments seek to “ban” bitcoin and facilitate the adoption of a controversial asset called Central Bank Digital Currency (CBDC). The essay argues that such claims rest in a failure of emerging technology’s advocates to understand commercial law terms of art and the purposes they serve in the UCC. Far from advantaging CBDCs, the 2022 UCC Amendments promote stability and predictability in commercial transactions involving cryptocurrency.
- I. THE BACKDROP: BITCOIN VS. CENTRAL BANK DIGITAL CURRENCIES
Recent concerns that the 2022 UCC Amendments push a pro-CBDC and anti-bitcoin agenda9 stem from a deep cultural and value clash between proponents of bitcoin and proponents of CBDCs. By way of brief background, bitcoin is a cryptocurrency intrinsic to the Bitcoin network. Introduced by Satoshi Nakamoto in 2009, the Bitcoin blockchain protocol provides a mechanism for recording electronic transactions through a distributed adversarial network in which it is computationally impractical for any party or group to retroactively modify transactions. Bitcoin enables the cryptographic demonstrability and relative permanency of each digital transaction, facilitates direct peer-to-peer financial transactions without intervention by a third-party intermediary, and incentivizes network support and security by issuing new bitcoin, subject to a cap, according to pre-determined rules coded into the network. Bitcoin is a medium of exchange laden with a variety of values, including preferences for: deflationary monetary economics, privacy, autonomy, and freedom in financial transactions.
These values stand in stark contrast to many of the technical and cultural elements of proposals to create CBDCs. The Board of Governors of the Federal Reserve System (FRB) defines CBDCs “as a digital liability of the Federal Reserve that is widely available to the general public.” Even while lauding potential benefits of CBDCs, such as convenience, safety, and liquidity, the FRB also expressed concern for potential negative effects. In particular, many worry that CBDCs will increase government financial surveillance, restrict financial autonomy, and potentially disincentivize savings, among other economic implications. Ultimately, as a result of these issues, the face-off between bitcoin and CBDCs acts as a battleground over important value and political differences.
While this value-laden and politically-tense debate over the nature of money and alternative payment mechanisms brewed, a variety of stakeholders began a completely unrelated, deliberative, and open process to amend the UCC considering the last decade’s technological advances. One key issue posed by emerging technology centered on improving the commercial law rules for digital assets such as bitcoin.
- II. THE PROBLEMATIC TREATMENT OF BITCOIN UNDER EXISTING UCC PROVISIONS
A variety of lenders secure loans using cryptocurrency as collateral. As early as 2014, commercial lawyers and scholars pointed out the potential limiting effect of existing UCC provisions for the negotiability of encumbered cryptocurrency. Under the existing UCC provisions, bitcoin (and other cryptocurrency) is a general intangible. When a lender takes general intangibles as collateral for a secured loan, the lender may only perfect its security interest by filing a financing statement in the relevant filing office. As discussed in further depth below, bitcoin’s treatment as a general intangible caused two problems for those lending against bitcoin as collateral: (1) crypto-native lenders lacked an optimal method of perfecting bitcoin collateral, and (2) bitcoin users could only ensure they received unencumbered bitcoin by conducting a search in the Article 9 filing system.
First, crypto-native lenders expressed concern about filing financing statements for fear of reducing the privacy interests of debtors. Lenders worried that third-parties could ascertain when a debtor owned cryptocurrency (including, say, bitcoin) and had perhaps borrowed against it. Debtors sought more privacy than that. As a result, some lenders began taking “control” of the bitcoin collateral by, for example, taking the bitcoin into a wallet the lender controlled. While this was good for gaining access to the collateral upon default, under the existing UCC, that lender, without filing a financing statement with the relevant filing office, remained an unperfected secured creditor. Such status, of course, would pose a problem if the debtor defaulted to another, perfected, secured creditor, or if the debtor became insolvent and filed for bankruptcy. In either case, the crypto-native lender with control of the bitcoin but no filed financing statement would lose in a contest for the value of the bitcoin collateral to a secured party who filed a financing statement or to the bankruptcy trustee. Second, treatment of bitcoin as a general intangible imposed a severe limitation on the negotiability of bitcoin. An onward transferee of bitcoin could never be sure without searching the filing system whether the bitcoin they received was encumbered or not.
Many initially think the answer to the problem of treating bitcoin and other cryptocurrencies as general intangibles lies in making bitcoin “money” under the UCC. Under the UCC “money” receives treatment as super-negotiable; a recipient of encumbered money from a debtor takes it free of a security interest granted by the debtor. However, ultimately, this solution remains suboptimal. Making intangible bitcoin “money” for UCC purposes is problematic because a security interest in “money” can only be perfected by possession. Possession in the UCC is a physical, tangible concept. You must be able to hold a thing in your hands in order to possess it. So, if you make bitcoin “money” for UCC purposes, you make it impossible to perfect a security interest in bitcoin, which is worse for lenders than classifying bitcoin as a general intangible — at least as a general intangible, an actual way to perfect a security interest exists.
- III. THE 2022 UCC AMENDMENTS RESPECT BITCOINS NEGOTIABILITY AND DECENTRALIZATION
The 2022 UCC Amendments offer nuanced resolutions to these issues. First, the amendments create a new category of asset for UCC purposes (and for UCC purposes only). That category of assets is called a “controllable electronic record” (CER). A CER “means a record stored in an electronic medium that can be subjected to control under Section 12-105.” In an innovative move, the technology agnostic 2022 UCC Amendments defer to the technical system of the CER to determine what constitutes control as a technical matter, so long the person who has control obtains: (1) the power to enjoy substantially all the benefit of the CER; (2) the exclusive power to prevent others from enjoying “substantially all the benefit” of the CER; and (3) the exclusive power to transfer control of the CER.34 Notably, exclusivity is not lost if it is shared by agreement (or by technology — such as multi-signature arrangements).
This definition of “control” serves two purposes: (1) it serves a definitional purpose — namely, not all electronic records are CERs, just those capable of being subject to the defined term control, and (2) lenders who take cryptocurrency, including bitcoin, as collateral, may now perfect security interests by control.36 Indeed, the amendments make control the preferred method of perfection for CERs over filing. This, of course, is exactly what existing industry players had already been doing — just without the legal benefits they would have wanted under the existing provisions of the UCC. The 2022 UCC Amendments seek to bring the law up to speed with what bitcoin-native secured lenders thought was best all along. Additionally, the 2022 UCC Amendments provide that if a purchaser of a CER (such as bitcoin) is a qualifying purchaser, the purchaser will benefit from a take-free rule; the purchaser gets an unencumbered CER. In this way, treating bitcoin and other cryptocurrencies as CERs resolves the two prominent problems lenders taking bitcoin as collateral face under the existing UCC provisions.
Far from favoring CBDCs, the 2022 UCC Amendments seek to facilitate the negotiability of CERs such as bitcoin. Without such rules as the take-free rules, bitcoin and other CERs would be at a disadvantage to CBDCs in terms of negotiability. Instead, the 2022 UCC Amendments preserve the negotiability of bitcoin and other CERs in a way that should better enable individuals to freely transact in bitcoin without worry that they are taking the bitcoin subject to a secret lien. This represents an extremely important change to commercial law rule for the maintenance of bitcoin and cryptocurrencies as freely transferable bearer-like instruments.
As the 2022 UCC Amendments were being drafted and debated, El Salvador adopted bitcoin as legal tender. Arguably, El Salvador’s move made bitcoin “money” under the existing UCC. Of course, this presents a problem because no lender can now perfect a security interest in bitcoin. Recall that “money” must be perfected by possession and possession is a concept for tangible things you can hold in your hands. The existence of intangible bitcoin as “money” does not fit within that model of perfection by physical possession. Further, some countries already developed CBDCs like the Sand Dollar. The Sand Dollar, as e-currency authorized by the Bahamian government, clearly falls under the UCC’s existing definition of “money,” leaving lenders with no way to perfect security interests in Sand Dollars or other CBDCs, because possession, as a physical concept simply does not work.
Further, as a form of legal tender, many expect CBDCs to integrate with the existing banking system, and the existing UCC rules already account for how to perfect in collateral like a deposit account (namely by control, defined in a different way). Notably, even El Salvador’s adoption of bitcoin integrates with the existing banking system similarly to CBDCs. El Salvador implemented its adoption of bitcoin as legal tender through the Chivo wallet, a custodial wallet that does not give users control over their private keys. The 2022 UCC Amendments could have taken its cue from the El Salvador implementation and required that perfection of bitcoin and other cryptocurrency take place via a custodial wallet provider or deposit account. The 2022 UCC Amendments opted for a different approach. Namely, to address the likely integration of CBDCs with the existing banking system while also attempting to honor the decentralized nature of cryptocurrencies and blockchain protocols like that found in bitcoin, the 2022 UCC Amendments kept the CER category for bitcoin and created a separate concept of “electronic money.”
“Electronic money” includes any “medium of exchange that is currently authorized or adopted by a domestic or foreign government,” but excludes “an electronic record that is a medium of exchange recorded and transferable in a system that existed and operated…before the medium of exchange was authorized or adopted by the government” (like El Salvador and bitcoin). Notably, this change does not preference CBDCs, but instead deals with unique issues. Namely, if electronic money is credited to a deposit account (which in UCC-speak means a bank account, and could include an account at a central bank), then the normal deposit account perfection rules will apply. If the electronic money collateral is not credited to a deposit account, then a security interest in electronic money could be perfected by control. As a practical matter, because of the nature of CBDCs, the default method of perfection in electronic money in practice will likely be by perfection of deposit accounts. It should come as no surprise, then, as to why treating bitcoin like “electronic money” and folding it into the definition of “money” would be sub-optimal. Namely, such treatment would likely encourage recentralization of bitcoin holdings through deposit accounts or intermediated securities accounts. Such recentralization would be a step in an incredibly wrong direction. Rather, enabling maximum party autonomy by allowing individualized control over a CER to act as a method of perfection for bitcoin and other cryptocurrencies represents a more beneficial approach, as signaled by the fact that crypto-native secured lenders employed this approach before the 2022 UCC Amendments project began. The separation between “electronic money” and CERs, far from somehow favoring CBDCs, respects existing commercial practice and the decentralized nature of bitcoin and other cryptocurrency.
The worries raised about the UCC including CBDCs in the definition of “money” while excluding bitcoin center on a concern that other laws might copy the definition for other purposes. In this regard, the private law nature of the UCC plays an important role. The UCC is not regulatory in nature, and the definition of “money” in the UCC has no direct impact on the definition of “money” for other legal purposes such as in taxes, anti-money laundering, money transmitter regulations, security regulations, commodities regulations, or even which mediums of exchange serve as U.S. legal tender. The definition of “money” in the UCC serves a narrow commercial law purpose: to provide predictability and stability in commercial transactions relating to a specific type of medium of exchange. The unique and decentralized nature of bitcoin and other cryptocurrency require a different approach to enabling stable and predictable commercial transactions involving those assets.
The 2022 UCC Amendments seek to preserve the decentralized nature of bitcoin and other cryptocurrencies, enable secured lenders to enjoy legal benefits of their existing commercial practices, and by protect the negotiability of bitcoin by allowing onward transferees to take bitcoin and cryptocurrencies free of existing encumbrances. Without an understanding of the role that the definition of “money” plays in the UCC, however, bitcoin’s proponents may miss the opportunity to support a law that respects some of bitcoin’s core values. Although unfamiliarity with blockchain-related terminology often motivates sub-optimal legislation and regulatory schemes for cryptocurrency, smart contracts, and other emerging technology, this battle over the 2022 UCC Amendments stems from the opposite: unfamiliarity with commercial law among proponents of emerging technology. Emerging technology’s language wars, it seems, run both ways.
In the case of South Dakota, while the governor’s rhetorical response reflects well on her political judgment, this proposed bill does not, unlike the Governor and others claim, tilt South Dakota toward a CBDC purgatory. Nor does it restrict Bitcoin’s adoption. It’s actually bullish for Bitcoin.
How this misunderstanding has metastasized through political discourse — from state governors to Bitcoin-friendly Congressmen — deserves its own deconstruction, but I’ll leave that to others.
The bill in question — based on an update to the Uniform Commercial Code — not only expands definitions and protections for Bitcoin, but actually creates a legal mechanism for recognizing self-custody and for the protocol’s inclusion in traditional lending, insurance, and commercial transactions.
In a sense, it’s an upgrade to existing commercial law that would allow Bitcoin to be used as collateral for all future financial contracts. It’s “not your keys, not your coins” in commercial law.
Not only would this bill protect your Bitcoin in any commercial transaction, but it would also better define and protect ownership of your Bitcoin in a bankruptcy scenario like FTX, Voyager, or BlockFi.
More at https://www.btcpolicy.org/articles/in-attempt-to-stop-cbdcs-states-are-rejecting-ostensibly-pro-bitcoin-legislation
submitted by /u/cranialnervous